The Nailhouse Shock Coming From China's Collateral Crisis

Our road to becoming a billionaire is crystal clear. We’re going to dub that iconic Australian movie The Castle into Mandarin and sell the DVD. We’ll be raking it in by the billion. Why will the Chinese buy it? Because China’s economic boom is based on the very same conflict that the movie is. The big difference is that in the movie, there’s a happy ending.

It’s all got to do with a whole bunch of seemingly unrelated stories. Nailhouses, collateral crises, corrupt politicians, debt, a computer game, and the Australian mining boom. Hopefully we can string them together for you.

The Castle

The Castle is an Australian movie about a family whose house is going to be demolished by the government. The local airport runway needs to be extended for economic growth and the greater good.

But the locals whose houses are in the way resist. The government attempts to force them to sell their homes to the airport. The highlight of the movie is when the local’s lawyer argues to the High Court of Australia that ‘the vibe’ of the constitution prohibits the forced sale. With a little help from a better lawyer, the homeowners eventually win.

Anyway, the Chinese people will find all this very poignant. They’ve even got a name for it.


Nailhouses are the Chinese name for houses like these:

Source: Wikipedia

Just like in ‘The Castle’, homeowners are refusing to sell out to developers and the government. They don’t want to leave their homes. So the Chinese government and developers simply build around them. The result is called a Nailhouse, because it is a house waiting to be hammered down.

It’s worth pointing out that in most Western countries, the government can make you sell your home under certain circumstances. In China, apparently, civil rights are much stronger. Different tactics must be used to overcome the right to own a house and stay in it.

Tactics like violence. So developers and local government has become notorious for sending their ‘heavies’ around to beat the homeowners up. Enter the Nailhouse computer game. You can play it for free here.

Source: Gamegape

It was inspired by real people who tried to defend their homes from government and developers with homemade weapons and fireworks. The gist of the game is to select family members to defend your home from developers trying to destroy it to make way for high rises. Each family member has a different weapon, fire rate and damage amount.

(Hint: the Mum who throws the flip flops is the best character to select first. Molotov cocktail throwing Dad is good if you upgrade him a lot.)

You’re up against developers and government officials. Our favourite developer is the one who rides his jackhammer like a pogo stick. If you let the developers get too close to the house without wiping them out, you start to lose your 100 lives.

The twist in the game is that you can only hold out so long. You always lose in the end. Just like Chinese homeowners. But what does this have to do with you and collateral crises?

The Source of China’s Economic Boom is Collateral in Crisis

The Chinese economic boom is built on expropriation of the people by government. Just like in ‘The Castle’ with the airport, it’s all a matter of local government and developers trying to create economic progress. But what’s different about China is that the underlying story is one of corruption and debt. And where there’s debt, there’s a collateral crisis in the making.

Lynette On may have found that collateral crisis. She explained in Foreign Affairs:
‘Governments borrow money using land as collateral and repay the interest on their loans using funds they earn from selling or leasing the same land.’

This exposes China’s booming economy to the kinds of collateral crises we like to warn Markets and Money readers about. If land values stagnate or drop, the debt paying for all the developments will suddenly stop flowing. That’s because lenders will stop lending if the value of collateral is falling. Without lending, there won’t be any building.

This is much the same as America’s sub-prime boom. While house prices are rising, it doesn’t matter if borrowers aren’t credit worthy. The worst case scenario is that they sell their home and pay off the mortgage that way.

The house was the collateral ensuring the lending agreement wasn’t risky. But as soon as house prices fell, all hell broke loose. All of a sudden the collateral wasn’t good enough. The same thing will happen in China, except that it is land which is used as collateral, not houses.

Australia’s Mining Doom

Unlike a business that continues to grow, sell things, and employ people, construction generates a burst of resource demand and then very little once the building is complete. That means Chinese resource demand is fragile. If construction stops, resource demand and GDP will fall to a much lower level. And very quickly.

Our recent trip to Dubai makes this something we can picture. There are vast amounts of unfinished buildings. At night we noticed that the left half of the neighbouring hotel was dark. They never finished the interior. The sudden stop in construction once debt stopped flowing devastated the local economy.

‘China is Dubai times 1000,’ legendary short seller Jim Chanos once said.

All this leaves Australia in an awful position. Without demand for resources, the faster half of our two speed economy becomes a ball and a chain. One that the mining tax has positioned over the Australian government’s big toe. Once it drops, ouch. All we need is a nailhouse shock that sends land values falling.

Of course, you can protect yourself from all this. Greg Canavan laid out exactly how here.

Until next week,

Nickolai Hubble.
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Nick Hubble
Nick Hubble is a feature editor of Markets and Money and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about Markets and Money, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails.

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You have heard of “eminent domain” and the Keystone XL pipeline? Please explain the difference in respect of your Chinese highway house photo? I wonder if pre-supposed, but yet to be evidenced, Chinese “draconian” actions in respect of tree or house sitters would be any different to that of recent US Presidential candidate Jill Stein who was arrested and taken to the Wood County jail, then subsequently charged with criminal trespass. Let’s do the whole urban land use and property rights and crown land lease regime thing, but let’s not imagine a point of difference in China when there… Read more »
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